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Here’s the dilemma.

Long-term emerging market stocks are going to beat stocks from the world’s developed economies like a drum.

Everything right now points in that direction.

  • Growth rates: For example, the United States looks likely to grow by 2% to 3% annually over the next decade (if it’s lucky) and China, India, and Brazil are projected to grow at twice to four times that speed.
  • Debts: Developed economies such as Japan, the United States, and the United Kingdom will spend the next decade trying to dig their way out from under a mountain of growth-crippling debt while China and the rest of the world’s developing economies have emerged from the global financial crisis with comparatively undamaged balance sheets.
  • Demographics: The developed world has to find a way to finance the “golden years” of rapidly aging populations. For the next decade, at least (and longer in the case of India), the economies of the developing world will be decisively younger. And growth, the historical pattern shows, goes to the young.

But in the short-term emerging stock markets look risky.

  • Everybody suddenly loves them. And every guru is saying, You’ve got to be in emerging market stocks.
  • Emerging market stocks are expensive. The companies in the MSCI Emerging Markets now trade at 24 times earnings. The last time the price to earnings ratio on this index was this high was in April 2000. Remember April 2000? Not the greatest of times to enter any market.
  • The Chinese government and central bank keep signaling that they’re going to start slowing bank lending—and every time they do the market jumps like a cat landing on a hot tin roof.
  • In the short-term emerging stock markets will take a licking if the developed world slides into another financial crisis. And that seems like a very real possibility somewhere in the belt that stretches from Athens west to Tokyo.

So is there a solution to this dilemma? A strategy that promises a way to navigate the short-term potholes while keeping your portfolio vehicle intact until the long-term arrives?

Sure. There are plenty of them. Let me lay out your choices and suggest those that make the most sense to me.

  1. Ignore the whole short-term problem thing and stomp down on that accelerator. Sure, Chinese stocks could fall 65% in a year but they’ll go up 80% the next year. Just put your money in and hang on. Great if you’ve got nerves of steel. If you don’t (and I know I don’t), this is a great way to buy high on optimism and sell low in panic over and over again.
  2. Dollar cost average your way through the potholes.  Put the same amount of money into an index fund or ETF (exchange traded fund) each month. When the market is expensive, you’ll wind up buying fewer shares. When it’s cheap, you’ll wind up buying more. As long as you pick low cost vehicles and have the discipline to keep to your schedule even when the markets get scary, this is a great strategy. It only works if you keep putting money in during the terrifying times. That’s when you pick up enough cheap shares to more than make up for the expensive shares you bought when everybody was in love with these markets.
  3. Avoid the riskier emerging markets now. For example, China’s markets present a high level of China specific risk right now. If Beijing lowers the boom on bank lending in 2010, that could send the Shanghai market into one of its patented panics. But it doesn’t mean squat for stocks in Brazil.
  4. Play the emerging markets story through the shares of developed market companies that derive a big percentage of their revenues from doing business in emerging economies. For example, one reason I like Johnson Controls (JCI) enough to put it in the Jubak’s Picks 12-18 month portfolio and in the Jubak Picks 50 long-term portfolio is the future growth potential in Asia in general and China in particular in the company’s automotive interior (42%) of sales and battery (following on the acquisition of Delphi’s battery unit) businesses.
  5. Buy value in emerging markets. Sure, the big names, the companies that everyone knows and that make up the bulk of the market capitalization indexes and ETFs, are expensive but there are lots of lesser known companies on emerging markets that trade at more reasonable prices. In Brazil, for example, everybody’s heard of Vale (VALE), the low-cost iron ore producer in the world. The stock trades at a price-to-sales ratio of 4.1 as a result. But what about Brazilian stocks such as AmBev (ABV)? The company controls about half of the Brazilian beer market and the stock sells at a price to sales ratio of 2.8. Or BRF Brazil Foods (BRFS), the country’s dominant chicken producer? That stock sells at a price to sales ratio of 1.5. You can find even cheaper stocks even in expensive markets if you dig deeper. And that’s true in China, India, and other emerging markets as well as in Brazil.
  6. Wait for the next dip and jump in. There will be a correction. These markets are so volatile it’s just about guaranteed. But there’s no guarantee when it will happen or that you’ll recognize it and jump in when everybody else is selling in a panic. If you want to follow this strategy, I hope you’re a better market time than I am. (Okay, who said, “That wouldn’t be hard”?)

Knowing what I know about these emerging markets (and the global economy in which they’re embedded) and about my own strengths and weaknesses as an investor, I’d pick strategies 3, 4, and 5 as my favorites.

I’ll be giving you some individual stock picks over the next few weeks that you can use if you decide to follow me down those paths.